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For a few tumultuous hours on April 19th, it seemed like deja ‘vu all over again. Global commodity and stock market operators held their collective breathe, as the Shanghai Stock Index tumbled as much as 7.2% to the 3,400 level, reviving fears of yet another gut wrenching global shake-out. Beijing had delayed the release of two key economic statistics until after the close of trading, heightening fears of bearish news that could derail the Shanghai freight train. After the close of trading, Beijing said consumer inflation had hit 3.3% in March, its highest in more than two years, and far above 2.7% in February. China’s economy is overheating, expanding at an 11.1% annualized clip in Q’1, and factory output is 18.5% higher from a year ago. The news of above target inflation, jolted China’s 5-year bond yields upward by 50 basis points to 5.25%, to its highest in two years, on fears the People’s Bank of China (PBoC) might actually tighten liquidity. And what happens in Shanghai is of great interest to global commodity and stock market operators, because China is the locomotive of global economic growth, and its staggering factory output is matched by its demand for industrial commodities. China’s share of global demand growth for commodities between 2002 and 2005 was: 51% for copper, 48% for aluminum, 87% for nickel, 54% for steel, 86% for tin, 113% for zinc, and 30% for crude oil.
The PBoC began its pseudo tightening campaign to absorb billions of dollars of excess funds pouring into Shanghai’s money markets from its ballooning trade surplus, foreign direct investment, and hot money flows into yuan denominated securities. But traders weren’t fooled by the psuedo tightening. Bond yields stayed near historically low levels, and the stock market tripled, because the central bank focused mostly on soaking up excess liquidity rather than raising interest rates. Chinese Traders take Government Threats in Stride What briefly spooked the markets on April 19th was the idea that this pattern might change. The last PBoC rate hike in March left the benchmark one-year deposit rate at 2.79 percent. That means real deposit rates, when compared to a 3.3% inflation rate are negative 61 basis points, which encourages a flood of hot money into China’s frothy stock and real estate markets, which authorities say they want to prevent. Chinese Premier Wen Jiabao said on April 19th, that Beijing needed to take pre-emptive steps to prevent the economy from overheating in the face of excessive credit and money growth. “We need to prevent the economy from shifting from relatively fast growth to a state of overheating and to prevent big ups and downs. We will work hard to keep basic stability in the overall level of prices,” he said.
But Jiaboa has a major credibility problem. Over the past four years, the Chinese premier has vowed at least a dozen times to rein in the explosive growth of the M2 money supply, and to slow the economy towards 8-9% growth. But each year, Beijing fails to deliver. Instead, it inflates the M2 money supply at an average 18% clip, to keep the yuan undervalued and expand its economy at a 10% rate. The net result was a $232 billion trade surplus with the United States last year, and the loss of 3.2 million US manufacturing jobs, since the Bush administration took office. On the flip side, Chinese retail sales in Jan-Feb were 14.7% higher than a year ago, and industrial and bank profits are surging to record highs. Chinese exports soared to a record $252 billion in the first quarter, up 27.8%, while imports rose to $205.7 billion, up 18.2% from the same period a year earlier.
China and India’s enormous appetite for raw materials have lifted global freight costs for dry commodities to record highs, with congestion at Australian coal and mineral ports at 20-days. The Baltic Exchange’s Cape-Size Freight Index, an indicator of global minerals demand, added 190 points to 8,795 on April 23rd, within easy reach of the December 2004 record of 8,911. India’s industrial output was 11% higher in March from a year ago, accounting for 25% of its economic activity. Clandestine Agreement between US Treasury and Beijing China's reserves have ballooned in recent years as the central bank, in order to hold down the yuan, has bought most of the dollars generated by a growing trade surplus, inflows of foreign direct investment and speculative capital. The central bank said on April 12th, that it FX reserves mushroomed by $135.7 billion to $1.2 trillion between January and March, more than half the $247.3 billion reserves accumulation for the whole of 2006. About 70% of China’s FX reserves are held in US bonds.
But while Beijing’s has steered towards safe and stable investments, Chinese leaders might start to diversify the hoard into commodities or non-US dollar currencies. China might decide to dump some of its US dollar holdings, setting off a tidal wave of T-bond sales and imperiling the US economy. Instead, Beijing might buy oil fields, copper mines or even agricultural land to help sustain the country’s development. US Treasury chief Henry Paulson played down such concerns, noting that China’s $416 billion of Treasuries are less than the value of an average day’s trading.
“US credit markets should be able to absorb without great difficulty any shift of foreign allocations,” wrote Federal Reserve chief Ben Bernanke in a letter to Sen. Richard Shelby, on March 16th. “And even if such a shift were to put undesired upward pressure on US interest rates, the Federal Reserve has the capacity to operate in domestic money markets to maintain interest rates at a level consistent with our economic goals,” Bernanke said. Thus, Bernanke indicates he’s prepared to print US dollars to buy back the debt that is sold to China. The net result of such actions could be the collapse of the US dollar on foreign exchange markets, higher gold prices, and spiraling inflation in the United States. The trigger for Chinese sales of US bonds could be “veto proof” protectionist legislation by the US Congress, aimed at Chinese imports. Two leading US Senate critics of China’s cheap yuan policy said on March 28th, they expected Congress to pass a “veto-proof” bill forcing Beijing to raise the value of the yuan against the dollar. “Well-crafted legislation, WTO-compliant and strong and effective is likely to pass with a veto-proof margin during this Congress,” said Sen. Charles Schumer, a New York Democrat. “That’s the message I hope the Chinese and the Bush administration take away from this hearing.”
At current growth rates, China’s economy would surpass the US in 25-years. But Chinese leaders worry that stiff US tariffs on Chinese imports could derail the world’s fastest growing economy, and burst the Shanghai stock market bubble. When push comes to shove with “veto proof” trade legislation in the second half of this year, Beijing would probably relent and allow the yuan to climb higher at a faster rate. But until the political posturing turns into action, the Shanghai bubble could try to match the last great Asian stock market bubble – the Nikkei-225 of 1986-89. Chinese retail investors opened more than one million new trading accounts during the third week of April, bringing the total for the first four months of 2007 to more than 10 million. This figure is greater than that of the previous four years combined, even as signs of a bubble are getting clearer by the day. The Shanghai stock index has risen 50% so far this year, after tacking on a 130% gain in 2006.
Chinese broker, Citic Securities, has tripled in value since early November, and is a good barometer of speculative sentiment in China. Citic Securities 600030.ss, Shanghai’s first listed broker, said its net profit in the first quarter of 2007 rose more than 12 times from the same period a year earlier. Revenue for the three months ended March 31st, was close to that for all of 2006. Speculative fever is running very high in China, and it’s not wise to stand in the way of an Asian stampede. The Shanghai Securities News said the number of new brokerage accounts established in a single day hit a record 282,000 on April 19th, the day of the market’s 7.2% plunge, bringing total accounts to over 90 million. This is a strong signal that market setbacks are not scaring Chinese traders away. And another PBoC interest rate hike might not scare speculators, because it would only adjust real interest rates from being sharply negative. Traders do not expect a sudden jump by the Chinese yuan, and believe authorities will hold appreciation for the rest of the year to around 3% to avoid hurting China’s export sector. Australian Traders Tracking the Aussie /yen and M3 The “yen carry” trade has permeated into all corners of the globe, and is especially attracted to higher yielding currencies, like the Aussie dollar. It’s been a wild rollercoaster ride, but Australia’s Stock Exchange (ASX-200) Index has been catapulted to astronomical heights, in large part, due to the endless flow of cheap capital from Tokyo. The Aussie dollar climbed 50% against the yen from its lows in 2001, but found resistance at the psychological 100-yen last week. The Aussie dollar also reached 84 US-cents, its highest in 17-years, helped by speculation the Reserve Bank of Australia (RBA) would raise its lending rate by a quarter-point from a six-year high of 6.25 percent. Last month, the RBA passed up a chance to lift its loan rate to 6.50%, despite explosive growth of the Australian M3 money supply, which is accelerating at a 14.3% clip, its fastest in 17-years. Much like the Bank of Korea, the RBA is reluctant to raise interest rates further, to prevent the Aussie dollar from climbing above 100-yen. Japan is Australia’s largest trading partner, and Australian Treasurer Peter Costello is trying to talk down the Aussie dollar to help local exporters. Earlier today, the Australian government provided the central bank with at least three months of breathing space, by conjuring-up a surprisingly low +0.1% inflation rate in the first quarter.
That translates into a 2.4% annual inflation from +3.3% in Q’4, and is now within the RBA’s 1% to 3% target range for the first time in 12-months, taking pressure off the central bank for an immediate rate hike. The government’s fuzzy math showed a 34% plunge in fruit prices offsetting a 13.3% spike in pharmaceutical costs, a 7.1% increase in school tuition fees, and higher home rents which climbed 1.4 percent. The drop in fruit prices was led by a whopping 73% plunge in banana prices. But while government apparatchniks were lowering the consumer inflation statistics, the central bank admitted in February that the Aussie M3 money supply is out of control, expanding at an explosive 14.3% annualized rate, it’s fastest in 17-years. That had led to expectations of an RBA rate hike to 6.50% in April or May to rein-in M3. But the Aussie dollar’s strength against the yen, handcuffed the RBA.
The RBA had been gradually lifting its overnight loan rate for the past five years, from as low as 4.00% in Q’1, 2002 to as high as 6.25% in November 2006. But the RBA’s slow-motion baby-step rate hikes didn’t contain the run-away M3 money supply. Neither did the RBA slow down bank loan demand, which is 13.2% higher from a year ago. Without a further tightening in RBA monetary policy, inflation pressures in the Aussie gold market could continue to simmer at the boiling point. Last year, the RBA intervened on a regular basis in the foreign exchange market, by selling A$3.6 billion, anxious to hold the Aussie dollar below the psychological 80 US-cents level. But “yen carry” traders and the Federal Reserve’s shift from a tightening bias to a neutral bias on March 21st, overwhelmed the RBA’s intervention efforts.
The stronger Aussie dollar against the deficit ridden US dollar and the ultra-low yielding Japanese yen, persuaded the RBA to keep its powder dry at 6.25% on April 3rd. But Sydney gold traders aren’t swayed by the government’s fuzzy math on inflation, and instead, are watching the growth of the M3 money supply Gold ended 0.8% higher in Sydney to A$634 /oz, following the surprisingly low inflation data, tracking a 14-basis point surge in Australian T-bill futures, which lowered the implied yield for June to 6.42%. The inflation report was a shocker for Sydney T-bill futures traders, leaving a huge gap on the daily charts, while scaling back expectations of an RBA rate hike to the fourth quarter. Treasury chief Costello said Australian inflation hit a peak in the middle of last year and appears to have decelerated. “The headline inflation rate will go lower. You will see a headline rate next quarter below 2 per cent,” he declared. Ironically, with the RBA handcuffed on rate hikes by the Treasury chief, Sydney gold traders have a green light to bid the yellow metal higher in the weeks ahead.
Ordinarily, sharply lower interest rates would be construed as bullish for blue-chip stocks. But the ASX-200 ended 20-points lower after the benign CPI report, because “yen carry” traders unwound long positions in Aussie stocks, while the Aussie dollar came under selling pressure vs the yen. The ASX-200 Index is in the hands of “yen carry” traders, and the psychological 100-yen level for the Aussie$, proved to be a barrier for the ASX-200 Index at the 6,250-level, an all-time high.
With so much riding on the Aussie /yen exchange rate, it’s interesting to note, that the interest rate differential between the six-month Aussie Libor and the Japanese yen Libor shrank to +560 basis points from +588 basis points after the release of the CPI data. Still, the Aussie dollar retains a wide interest rate advantage over the yen, and carry traders could look to buy the commodity currency again at the next support level. The next Bank of Japan rate hike to 0.75% is not expected until June. The possible unwinding of the “yen carry” trade makes the Asian and European stock markets skittish.
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